Cushman President on Luck, Stocks and Borrowing

One of the most outspoken executives in the Los Angeles commercial real estate world has long been John C. Cushman III, president and chief executive of Cushman Realty Corp., which he founded in 1978 with his brother Louis B. Cushman, the company’s chairman. Cushman, whose brokerage firm has represented a host of Fortune 500 companies in some of the biggest deals in Los Angeles and other major U.S. cities, is known for his sharp assessments of the real estate industry and forecasts on where it is headed.

Cushman, who will be a featured speaker at The Times-sponsored Real Estate Outlook Conference on Thursday at the Century Plaza Hotel in Century City, is also known for devoting much of his time to pursuits outside his business, including duties as vice chairman of the Los Angeles Area Council of the Boy Scouts of America and a board member of Town Hall of Los Angeles, the L.A. World Affairs Council, Junior Achievement and the USC Board of Advisors. When he’s not doing deals, Cushman likes to spend time at one of his favorite pieces of real estate, his ranch in Idaho.

Question: How does today’s commercial real estate market compare with healthy markets of previous years?

Answer: This recovery is different. It’s being driven by high-tech and telecommunications and diversified job growth in industries like the entertainment sector and international trade. There is also a flood of domestic capital chasing real estate. In the 1980s, we were not flush with capital in the United States. We didn’t export capital. Americans today are investing in Thailand, Korea, China--all over the world. In the previous cycle, we went to Japan looking for their money. Now, the Japanese are quietly and discreetly selling assets.

Q: Is there anything that worries you about current market conditions?

A: I’m convinced we’re going to see inflation because with the employment rate so low, there is so much demand for jobs in all sectors that employers are having trouble getting the people they need to run their businesses. Also, we are not out of the woods on what could go wrong in Asia. If the banks in Japan go into turmoil, it will destabilize the financial markets of the whole world, and if that happens, it will affect the global equity markets, which will cause pain and heartache in America--not just in real estate but in all of the capital and equity markets here and everywhere else in the world. It’s not just Japan that we have to worry about, either. There is a lot of bad bank debt out there in other countries.

Q: Despite the Southern California real estate rebound, downtown Los Angeles is lagging other U.S. central business districts in recovering. What’s your outlook on downtown’s future?

A: Los Angeles has recovered slower than any other downtown in the country, but the real question is whether there’s anything fundamentally wrong with downtown L.A. The answer is no. Downtown has been the victim of extraordinarily bad luck, and some of the vacancy numbers are misleading, but there is nothing wrong with its fundamentals. The outlook for downtown is very bright.

Q: What sort of bad luck and how are the numbers misleading?

A: It looks like a lot of corporations have left downtown, but they never really left, they were acquired in banking consolidations. Downtown has been the victim of bad luck in terms of the space that has been left vacant because of these consolidations.

The vacancy rate is misleading because it includes so many older buildings that were built before 1960, many of which are obsolete. They’re all included in the 32 million square feet that’s used to make the calculations on vacancy rates, but that’s misleading because what really matters is the vacancy rate in Class A space, the very best buildings, which is about 16%. Even if you do look at all of the space, including the obsolete buildings, the vacancy rate has improved to about 23% today from 28.46% in 1992.

Q: What makes the older buildings obsolete?

A: Not all of them are obsolete, but many of them have the wrong floor sizes and shapes for today’s tenants, the wrong depth between the windows and the core, and little or no parking. Many of them are in the wrong location. If the height between the floors isn’t right, there isn’t enough room to add the cabling that you need to make these buildings meet modern demands for power and technology.

Q: What’s going to happen to these buildings?

A: That’s a tricky question because some of them are architecturally protected as historical landmarks and some can in fact be adaptively reused for housing or other purposes. But many of them can’t be saved and should in fact be imploded. A lot of them are just going to sit there.

Q: What makes you so optimistic about a downtown that has been so slow to recover?

A: For one thing, big blocks of contiguous space in premier buildings are already getting hard to find. Those blocks have all but disappeared for companies looking for over 100,000 square feet. Another factor is Staples Arena. That’s a $300-million project that will have over 300 events per year, and in addition there will be an entertainment-retail center next to it. That’s going to breathe new life into downtown like we haven’t seen for 25-plus years. There are also other projects, like the new [Catholic] cathedral and the new Disney hall, that are going to revitalize downtown.

Q: But still no plans for new office space?

A: No, and I don’t see the prospect for much new construction downtown before the year 2005. The reason is very simple. Downtown still has the highest-quality office space at the lowest price in the state because the vacancy rate is still relatively high. You will not see new construction until the vacancy rates drop below 10% for direct and sublease space. And then what will happen is that rents will rise. Eventually, when rents go high enough to justify new construction, we have plenty of parcels of land that are prime for development.

Q: What do you see as the hot geographic markets in Southern California?

A: There’s no question the tri-cities area of Glendale, Burbank, Pasadena is going to continue to do well. The political leadership and the balance between the public and private sectors tend to be better there than in Los Angeles. The Valencia area is also very strong. We’re finding lots of companies that want to go out there. Long Beach is also going to be the center of a lot of activity because it has a tremendous concentration of energy companies, shipping companies and freight forwarders, trading companies and all of the others involved in international trade. The city also has good political leadership. People know what to expect, unlike in Los Angeles.

Q: What do you expect to happen to real estate investment trusts?

A: There is going to be a lot of consolidation. There were too many REITs when we started, and about a third of them in my opinion were born to raise cash to satisfy uncovered loan obligations. There are some very, very good REITs, but there is plenty of turmoil in the REIT market and there are plenty of billion-dollar REITs that are going to get gobbled up.

Q: What will determine who survives and who gets gobbled?

A: The ones who do well will be those who understand the fundamentals of the real estate business. One of the problems for some of the REITs is that they are run by people who weren’t grounded in fundamentals of real estate. Some were bright young people out of Wall Street who were involved in financial engineering. They were able to buy properties from the RTC [Resolution Trust Corp., the federal agency that liquidated the assets of failed savings and loan associations] at 30 cents on the dollar, so their assets were bound to increase in value. But those days are over now. Now it’s all about fundamentals and knowing the real estate business, and a lot of these people don’t know what they’re doing. They’re going to have to prove to the Street and the public that they can really operate these buildings they bought.

Q: Does the coming consolidation in REITs mean that bigger is better?

A: Bigger isn’t necessarily better, and smaller isn’t necessarily better. I think better is better.

Q: What will the changes in the REIT world mean to those who invest in REIT stocks?

A: I believe many of the REITs are going to trade more like fixed-income securities than growth stocks. They’re going to be driven much more on yield than growth. That’s an important distinction.

Q: Are buyers paying too much for commercial properties today?

A: Sure, some people are paying too much because they’re not good operators. Some of them will get in trouble by paying too much, but the smart buyers know what they’re doing. In the peak of the late 1980s and early 1990s, we hit over $500 per square foot in office building sales. We’re not there yet, but it’s coming.

Q: What advice do you have for a beginning investor in commercial real estate today?

A: You can’t compete with the big REITs and big investors. You’ve got to stay beneath the radar screen if you’re a beginner. You’ve got to do smaller industrial deals and then maybe package them and sell them to the REITs. You’ve got to go after assets that are overlooked by the big investors.

Q: Where are we now in terms of the commercial real estate cycle?

A: We’re at the upper part of the cycle, but it’s anybody’s guess how much longer it will go. A good guess might be two or three years, but nobody really knows. Conditions can get destabilized by events anywhere in the world. I’m not expecting that to happen, but I think the Asian situation is a reality check and a wake-up call that hopefully will remind us to keep our eye on what’s happening in the rest of the world.